What is a growth stock?
A growth stock is any company that has high earnings growth rate. This can be due to strong marketing, great product, etc. A lot of investors are drawn to companies that have these types of stocks because they feel this will lead to higher returns in the future.
In Goldman Sachs’ growth stock report, they explain growth stocks and what they believe should be the growth rate in order for a company to make it on their list.
In their growth stock report, Goldman Sachs said that companies could be considered growth stocks if they had an earnings growth of at least 25% over the last five years. They also added that while revenue growth is important there needs to be a big focus on profit growth as well.
Goldman Sachs also added that growth stocks need to have expected earnings growth of at least 20% in the next year. They added that this growth rate should be somewhere around 17-20% over the next few years.
The growth rate also needs to be sustainable. If there growth is due to risky behavior the growth growth might not last. For example, growth stocks in the tech industry tend to have high growth rates because they are constantly scrambling for new breakthroughs.
Growth stocks are typically growth for a reason. A growth stock can show growth due to risky endeavors but growth stocks with sustainable growth tend to be good investments.
One of the most successful growth stocks, for example, was Amazon (AMZN) Amazon grew largely due to their growth in the cloud computing business. Their growth was so strong that it led them to have almost a 100% growth rate in 4 years.
Amazon started off as a growth stock and has since then become a staple in nearly all growth portfolios.
Benefits of growth stocks:
Growth stocks have the potential to really pay off for investors. They have strong earnings growth, which can lead to huge returns in the future. For example, Amazon’s earnings growth over the past few years ranges from 20-100%. These gains are simply exceptional for an investment like Amazon.
Another benefit of growth stocks is that growth stocks tend to be the leaders of new growth industries and reward investors handsomely for sticking with them.
Amazon was one of the first growth stocks in e-commerce and is now an industry leader. Investors who were able to get on board with Amazon early enough got some very big returns because they were part of this growth stock’s growth story.
A further benefit of growth stock investing is that growth stocks tend to be the ones that are paving new growth paths. Growth stocks can be a way for investors to tap into growth that will most likely continue to innovate from new angles.
For example, Amazon started off with a very strong growth story in e-commerce but has since then grown substantially due to their cloud computing business as well. They have been able to grow their earnings by investing more money into various growth areas.
Dangers of growth stocks:
One major danger when investing growth stocks is the risk they pose. Growth stocks typically have a very small market cap which leads to higher volatility. If growth stocks go down, they can go down in a big way.
It is important for investors to make sure growth stocks are priced properly and that they have an exit plan if their growth stock doesn’t live up to expectations.
Another danger of growth stock investing is that growth stocks can take a long time to mature. This means that growth stock prices may not increase for five years or even more than ten years.
It is hard to calculate growth stocks and growth companies can sometimes lose their growth story and thus become undervalued.
How should you incorporate growth stocks into your portfolio? That depends on the growth stock and the investor’s own risk tolerance. Investors who like growth stocks but want to take a measured approach can choose to add growth stocks in their portfolio over time.
The fact that growth stocks sometimes take a very long time to mature is why investors might want to slowly introduce growth stocks into their portfolios instead of going all in.
This allows investors to manage their risks better and buy growth stocks when they are at a good value, thus limiting downside risk.
On the other hand, growth investing can be a path for investors who have the stomach for it. Growth investing typically takes longer periods of time which means that losses may be incurred during large market declines since growth investments tend not to recover as fast after downturns.